The bond vigilantes are having their moment in the sun.
The 10-year Treasury yield is above 5.2% and the 30-year yield has surged to its highest level since 2004 as their prices have tumbled. The iShares Core U.S. Aggregate Bond exchange-traded fund, which tracks the U.S. investment-grade bond market, has fallen nearly 5% this year, while the S&P 500 has climbed nearly 13%.
Investors continue to worry about inflation and the potential for more interest-rate increases from the Federal Reserve, and the so-called vigilantes are driving up government borrowing costs as concerns mount about higher government spending.
Stocks, of course, remain the preferred place to be for appreciation, thanks to healthy earnings growth over time. But if you're a more conservative investor who is worried about inflation and wants steady income, bonds still have a place in your portfolio.
So what should you do next as long-dated Treasuries continue to sell off ? While rising yields are painful for current bondholders, there are pockets of opportunity elsewhere in fixed income for buy-and-hold investors who want to collect interest at attractive rates. Experts say look to shorter-term bonds, higher-quality corporate debt, and even overseas as haven Treasuries get hammered.
JoAnne Bianco, senior investment strategist for fixed-income investment firm BondBloxx, recommends focusing on earning steady bond income instead of trying to bet on the path of interest rates.
"There is something for everyone in this market and people are benefiting from higher yields across the board," she tells Barron's.
In the current environment, snapping up shorter-term Treasuries might be worthwhile to minimize volatility. Mona Mahajan, head of investment strategy and asset allocation at Edward Jones, told Barron's that shorter-term Treasuries (think maturities between one and five years) look attractive now, especially when compared with cash. The 1-year Treasury bill sports a yield of just under 4.5%, for example, and is less sensitive to changes in longer-term interest rates.
Mahajan, however, isn't overly concerned that long-term yields are going to climb that much higher. While inflation is still higher than the Fed would like, it is heading in the right direction, she says. So, fears that the Fed is going to aggressively raise rates are overblown, she adds. The central bank's latest projections call for just one more quarter-percentage-point rate increase this year, and none in 2027.
"These rate hikes are a midcycle adjustment. This is not the beginning of a new hiking cycle," Mahajan said.
Brendan Murphy, head of fixed income for North America at Insight Investment, agrees. His argument: Current inflation fears are being fueled (pardon the pun) by higher oil prices, as opposed to wage gains. Energy costs remain volatile because of the war in Iran, but the eventual reopening of the Strait of Hormuz will help alleviate bond market jitters about inflation, he says.
As a result, Murphy is cautious on longer-term Treasuries because of interest-rate volatility. He says that shorter-term bonds-particularly mortgage-backed securities and asset-backed securities-could be worth a look instead, for their higher yields and slightly lower rate sensitivity.
The iShares MBS ETF and Vanguard Mortgage-Backed Securities ETF are two popular fund options for investors. Both have yields of around 4.5%, above the 4.15% yield for the benchmark iShares Core U.S. Aggregate Bond ETF.
Investment-grade corporate debt could also make sense, even with some worries about hyperscalers flooding the market to fund more spending for the artificial-intelligence buildout. Corporate bonds are also tied more closely to their issuers' financial health, which is strong for most big tech companies, thanks to continued expectations of robust earnings growth.
"Within credit you want to focus on higher quality," Doug Longo, head of fixed income portfolio strategists at Dimensional Fund Advisors, told Barron's. The Dimensional Core Fixed Income ETF focuses on AAA- and AA-rated corporate bonds as well as Treasuries and has a 4.5% yield.
Longo added that yields for municipal bonds are attractive too. The combination of higher rates and the tax-exempt status for many types of federal and state and local munis makes them advantageous for investors.
There has been an uptick in interest for munis too, according to BondBloxx's Bianco, who noted her firm's muni funds have seen more inflows in recent months. Goldman Sachs also said in a recent report that muni bond funds inflows overall have totaled $69 billion through August.
There are attractive high yields outside of the U.S., too. Bianco said there is growing demand for government bonds of emerging markets. For instance, the BondBloxx JPMorgan USD Emerging Markets 1-10 Year Bond ETF, with a yield of 5.6%, has exposure to short-term sovereign debt from Saudi Arabia, Turkey, Argentina, Mexico, and other notable emerging markets.
So the spike in bond yields, even though it means lower prices, isn't likely to dissuade conservative investors from sensing a good opportunity to generate more income by buying more bonds.
"Bond investors aren't day trading. Bonds are part of a broader allocation mix," Thomas Urano, co-chief investment officer at Sage Advisory, told Barron's. "Forward returns look compelling. Fixed income can cushion you from further rate hikes by the Fed and still wind up with positive gains."
As long as rates remain elevated, fixed income investors can keep clipping those coupons so to speak.
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